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IMF and Reforming Energy Subsidies

Who Benefits from Energy Subsidies: An UpdateNew

Energy subsidies are an important policy issue for all countries. Not only do energy subsidies have negative economic and environmental effects, they also mainly benefit the wealthiest households. A number of studies have shown that energy subsidies are very badly targeted, further reinforcing existing income inequalities; for instance, a recent review finds that the richest 20 percent of households receive six times more in subsidies than the poorest 20 percent. However, energy subsidy reform can still have a significant adverse impact on the welfare of low-income households and mitigating this impact is a key component of any energy subsidy reform strategy. This calls for tools to assess the magnitude of the welfare impact with the view to inform the design of appropriate mitigating measures to protect the most vulnerable households.

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The impact of changes in energy prices on the welfare of households occurs through a direct and an indirect channel. The direct impact arises when households purchase energy products for cooking, heating, lightning, and private transport. The indirect impact arises when households purchase goods and services that are produced by using energy products. The magnitude of the direct impact depends on the share of cooking, lighting, heating, and private transport in total household consumption, whereas the magnitude of the indirect impact depends on the fuel intensity of the production of other goods and services. The distribution of the impacts across the different segments of the population will be driven by the relative importance of these factors across these groups as well as the relative price increases of different energy products. To facilitate such analyses, staff at the Fiscal Affairs Department in the IMF have developed an excel-based tool the evaluate these direct and indirect impacts and their distribution across household income groups. Supporting Stata programs and a user guide are also available.


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IMF Working Paper: How Large Are Global Energy Subsidies? May 2015New

How Large Are Global Energy Subsidies?
IMF Working Paper: How Large Are Global Energy Subsidies? May 2015 | Excel file for figures and tables

Read Blog by Vitor Gaspar and Benedict Clements
Read Blog by Sanjeev Gupta and Mick Keen
Presentation by Vitor Gaspar

This study provides a comprehensive, updated picture of energy subsidies at the global, regional, and country levels. It focuses on the broad notion of post-tax energy subsidies, which captures the failure to charge for the environmental damage from energy consumption as well as to tax energy consumption in the same way as other consumption goods to raise government revenues. The study also estimates the fiscal, environmental and welfare gains from eliminating these energy subsidies.

The key findings of the study are as follows. First, post-tax energy subsidies are dramatically higher than previously estimated, and projected to remain high despite the sharp decline in international energy prices. Second, the vast majority of energy subsidies reflect domestic externalities, so countries should move ahead with energy subsidy reform unilaterally in their own interests. Third, the potential fiscal, environmental and welfare impacts of energy subsidy reform are substantial. Using the fiscal dividend to lower distortionary taxes or increase productive public spending could further improve welfare and economic growth.




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Measuring Energy Subsidies

When defining energy subsidies it is important to distinguish between consumer and producer subsidies. Within consumer subsidies it is also useful to distinguish between pre-tax and post-tax consumer subsidies since differences in estimates in the literature most often reflect a different focus on these subsidies.

Pre-tax consumer subsidies exist when energy consumers pay prices that are below the costs incurred to supply them with this energy. For internationally traded energy products, like natural gas and petroleum products, the supply cost used to calculate subsidies is the international price adjusted for distribution and transportation costs. Where the energy product is non-traded, like electricity, the supply cost is the price at which the domestic producer recovers costs, including a normal return to capital.

Post-tax consumer subsidies exist if consumer prices for energy are below supply costs plus the efficient levels of taxation. The efficient level of taxation includes two components. First, energy should be taxed the same way as any other consumer product. Second, some energy products contribute to local pollution, traffic congestion and accidents, and global warming—efficient taxation requires that the price of energy should reflect these adverse effects on society. In most countries, taxes on energy fall far short of the efficient levels.

Producer subsidies exist when producers receive either direct or indirect support that increases their profitability above what it otherwise would be. This support can take many forms, including receiving a price for the output above the supply cost, paying a price for inputs below supply costs, or receiving a direct transfer from the budget. In practice, producer subsidies tend to substantially smaller in magnitude than consumer subsidies.

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A Global Picture of Energy Subsidies

Pre-tax subsidies (including pre-tax consumer subsidies and producer subsidies) were estimated at US$541 (0.7 percent of global GDP) in 2013 and projected to decline to US$333 (0.4 percent of global GDP) in 2015, reflecting both the decline in international energy prices and an assumption that many countries would only partially pass-through those reductions to retail prices. Post-tax energy subsidies were estimated at $4.9 trillion (6.5 percent of global GDP) in 2013 and projected to remain high, at $5.3 trillion (6.5 percent of global GDP) in 2015.

In dollar terms, Emerging and Developing Asia accounts for about half of global post-tax subsidies with advanced economies accounting for about one quarter. In percent of GDP, post-tax subsidies are highest in Emerging and Developing Asia and Commonwealth of Independent States (CIS), at over 15 percent of regional GDP. In addition, the vast majority of post-tax subsidies reflect domestic externalities with only about a quarter from global warming.

Energy subsidies by component and region, 2015

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Consequences of Energy Subsidies

Subsidies are intended to protect consumers by keeping prices low. But they also come at a high cost. Subsidies are expensive for governments—and therefore taxpayers—to finance and can hinder governments’ efforts to reduce budget deficits. They also compete with other priority public spending on roads, schools, and healthcare.

All consumers—both rich and poor—benefit from subsidies by paying lower prices. Governments could get more “bang for their buck” by removing or reducing subsidies and targeting the money directly to programs that help only the poor.

Subsidies encourage excessive energy consumption, which accelerates the depletion of natural resources. They also reduce the incentive for investment in energy efficiency and other forms of cleaner energy. By encouraging wasteful use of energy, energy subsidies can also exacerbate the external vulnerability of countries to volatile international energy prices.

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The Benefits of Subsidy Reform

The fiscal, environmental and welfare gains from removing energy subsidies are substantial. At a global level, revenue gains in 2013 were estimated to be about US$3.0 trillion (4.0 percent of global GDP) and are projected to be US$2.9 trillion (3.6 percent of global of global GDP) in 2015. These reforms can also generate substantial environmental benefits, such as reductions in CO2 emissions and premature deaths from air pollution.

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Reform Efforts

In 2009, the Group of 20 advanced and emerging market economies called for a phase out of inefficient fossil fuel subsidies in all countries, and reaffirmed this again in 2012.

Despite the potential gains, many countries have had difficulty reforming subsidies. When reforms are made, prices increase, and this has often led to widespread public protests.

The absence of public support for subsidy reform is in part due to a lack of confidence in the ability of governments to shift the resulting budgetary savings to programs that would compensate the poor and middle class for the higher energy prices they face.

This problem is particularly challenging in oil-exporting countries, where subsidies are seen as a mechanism to distribute the benefits of natural resource endowments to their populations and where the capacity to administer targeted social programs is typically limited.

Governments are also often concerned that higher energy prices will contribute to a higher rate of inflation and adversely affect their competitiveness. Subsidy reform can also be complex when it includes trying to reduce inefficiencies and production costs, as is often the case for the electricity sector.

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A Plan for Reform

While there is no single recipe for successful subsidy reform, country experiences suggest that the following ingredients are needed:

  • a comprehensive energy sector reform plan with clear long-term objectives with an analysis of the impact of reforms;
  • transparent and extensive communication and consultation with stakeholders, including information on the size of subsidies and how they affect the government’s budget;
  • price increases that are phased-in over time;
  • improving the efficiency in state-owned enterprises to reduce producer subsidies;
  • measures to protect the poor through targeted cash or near-cash transfers or, if this option is not feasible, a focus on existing targeted programs that can be expanded quickly; and
  • institutional reforms that depoliticize energy pricing, such as the introduction of automatic pricing mechanisms.

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IMF Books and Papers

Books

Implementing a US Carbon Tax : Challenges and Debates
Implementing a US Carbon Tax : Challenges and Debates

Although the future extent and effects of global climate change remain uncertain, the expected damages are not zero, and risks of serious environmental and macroeconomic consequences rise with increasing atmospheric greenhouse gas concentrations. Despite the uncertainties, reducing emissions now makes sense, and a carbon tax is the simplest, most effective, and least costly way to do this. At the same time, a carbon tax would provide substantial new revenues which may be badly needed, given historically high debt-to-GDP levels, pressures on social security and medical budgets, and calls to reform taxes on personal and corporate income. This book is about the practicalities of introducing a carbon tax in the United States, set against the broader fiscal context.


Getting Energy Prices Right: From Principle to Practice
Getting Energy Prices Right: From Principle to Practice

Chapter Chapter 1  | Data Get the spreadsheet and data


The IMF study on Getting Energy Prices Right: From Principle to Practice offers practical guidance for countries on how to go about quantifying the harmful side effects of energy use, and shows what this implies for corrective taxes on coal, natural gas, gasoline, and road diesel, for over 150 countries.


Energy Subsidy Reform: Lessons and Implications
Energy Subsidy Reform : Lessons and Implications

Energy subsidies have wide-ranging economic consequences. Although they are aimed at protecting consumers, subsidies aggravate fiscal imbalances, crowd out priority public spending, and depress private investment, including in the energy sector. This book provides (1) the most comprehensive estimates of energy subsidies currently available for 176 countries and (2) an analysis of "how to do" energy subsidy reform, drawing on insights from 22 country case studies undertaken by the IMF staff and analyses carried out by other institutions.

Subsidy Reform in the Middle East and North Africa

In the Middle East and North Africa (MENA) countries price subsidies are common, especially on food and fuels. However, these are neither well targeted nor cost effective as a social protection tool, often benefiting mainly the better off instead of the poor and vulnerable. This paper explores the challenges of replacing generalized price subsidies with more equitable social safety net instruments, including the short-term inflationary effects, and describes the features of successful subsidy reforms.


Energy Subsidy Reform in Sub-Saharan Africa

The reform of energy subsidies is an important but challenging issue for sub-Saharan African (SSA) countries. There is a relatively large theoretical and empirical literature on this issue. While this paper relies on that literature, too, it tailors its discussion to SSA countries to respond to the following questions: Why it is important to reduce energy subsidies? What are the difficulties involved in energy subsidy reform? How best can a subsidy reform be implemented? This paper uses various sources of information on SSA countries: quantitative assessments, surveys, and individual (but standardized) case studies.


Energy Subsidy Reform: Lessons and Implications


Case Studies on Energy Subsidy Reform: Lessons and Implications


Technical Assistance Reports

Angola: Technical Assistant Report - Angola - Fuel Price Subsidy Reform the Way Forward


Mali : Technical Assistance Report - Mining Taxation: Modeling of Five Mining Operations

Most of the mines are old, but a number of them still have substantial reserves; extensions are planned for the Syama, Morila, Kalama, Tabakoto-Segela, and Loulo-Gounkoto mines. One mine, Robex, is expected to go into production soon, and a feasibility study has been submitted for the Fekola mine. Preparatory works for the Kodiéran mine, held by Wassoul’or, could resume during 2015 following the payment of over CFAF 7 billion to various creditors. Accordingly, Mali’s declining gold production could be sustainably reversed in the coming years if international prices remain at current levels.


Working Papers

How Large Are Global Energy Subsidies?

This paper provides a comprehensive, updated picture of energy subsidies at the global and regional levels. It focuses on the broad notion of post-tax energy subsidies, which arise when consumer prices are below supply costs plus a tax to reflect environmental damage and an additional tax applied to all consumption goods to raise government revenues. Post-tax energy subsidies are dramatically higher than previously estimated, and are projected to remain high. These subsidies primarily reflect under-pricing from a domestic (rather than global) perspective, so even unilateral price reform is in countries’ own interests. The potential fiscal, environmental and welfare impacts of energy subsidy reform are substantial.


Energy Subsidies and Public Social Spending: Theory and Evidence

This paper shows that high energy subsidies and low public social spending can emerge as an equilibrium outcome of a political game between the elite and the middle-class when the provision of public goods is subject to bottlenecks, reflecting weak domestic institutions. We test this and other predictions of our model using a large cross-section of emerging markets and low-income countries. The main empirical challenge is that subsidies and social spending could be jointly determined (e.g., at the time of the budget), leading to a simultaneity bias in OLS estimates. To address this concern, we adopt an identification strategy whereby subsidies in a given country are instrumented by the level of subsidies in neighboring countries. Our Instrumental Variable (IV) estimations suggest that public expenditures in education and health were on average lower by 0.6 percentage point of GDP in countries where energy subsidies were 1 percentage point of GDP higher. Moreover, we find that the crowding-out was stronger in the presence of weak domestic institutions, narrow fiscal space, and among the net oil importers.


The Unequal Benefits of Fuel Subsidies Revisited: Evidence for Developing Countries

Understanding who benefits from fuel price subsidies and the welfare impact of increasing fuel prices is key to designing, and gaining public support for, subsidy reform. This paper updates evidence for developing countries on the magnitude of the welfare impact of subsidy reform and its distribution across income groups, incorporating more recent studies and expanding the number of countries. These studies confirm that a very large share of benefits from price subsidies goes to high-income households, further reinforcing existing income inequalities. The results can also help to approximate the welfare impact of subsidy reform for countries where the data necessary for such an analysis is not available.


Energy Subsidies in Latin America and the Caribbean: Stocktaking and Policy Challenges

The oil price decline creates an opportunity to dismantle energy subsidies, which escalated with high oil prices. This paper assesses energy subsidies in Latin America and the Caribbean—about 1.8 percent of GDP in 2011–13 (approximately evenly split between fuel and electricity), and about 3.8 percent of GDP including negative externalities. Countries with poorer institutions subsidize more. Energy-rich countries subsidize fuel more, but low-income countries are more likely to subsidize electricity, as are Central America and the Caribbean. Energy subsidies impose fiscal costs, hurting SOEs, competitiveness, and distribution. The paper overviews country experience with subsidy reform, drawing lessons.


Technical Notes and Manuals

Automatic Fuel Pricing Mechanisms with Price Smoothing: Design, Implementation, and Fiscal Implications

Many developing and emerging countries do not fully pass-through increases in international fuel prices to domestic retail prices, with adverse consequences for fuel tax revenues and tax volatility. The adoption of an automatic fuel pricing mechanism can help to address this problem, and the incorporation of a price smoothing mechanism can ensure pass-through over the medium term but also avoid sharp increases (and decreases) in domestic prices. This technical note addresses the following issues: (i) the design of an automatic fuel pricing mechanism; (ii) the incorporation of domestic price smoothing and resulting tradeoffs; (iii) the transition from ad hoc pricing adjustments to an automatic mechanism; and (iv) policies to support this transition and the maintenance of an automatic mechanism. A standardized template for simulating and evaluating the implications of alternative pricing mechanisms for price and fiscal volatility is available on request.


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IMF Videos on Energy and Environment

Webcast Archive of the event held at the Brookings Institute, May 18, 2015